UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2000.
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
COMMISSION FILE NUMBER 333-93069
---------------
UTSTARCOM, INC.
(Exact name of Registrant as specified in its charter)
---------------
DELAWARE 52-1782500
(State of Incorporation) (I.R.S. Employer Identification No.)
1275 HARBOR BAY PARKWAY, ALAMEDA, CALIFORNIA 94502
(Address of principal executive offices) (zip code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 864-8800
---------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
As of July 31, 2000, there were 93,927,105 shares of the Registrant's
Common Stock outstanding, par value $0.00125.
This quarterly report on Form 10Q consists of 29 pages of which this is
page 1. The Exhibit Index appears on page 28.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE
Item 1. Condensed Consolidated Financial Statements 3
Condensed Consolidated Balance Sheet as of June 30, 2000 (unaudited) and
December 31, 1999 3
Condensed Consolidated Statement of Operations for the three and six month
periods ended June 30, 2000 and June 30, 1999 (unaudited) 4
Condensed Consolidated Statement of Cash Flows for the six month periods ended 5
June 30, 2000 and June 30, 1999 (unaudited)
Notes to Condensed Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 10
Item 3. Quantitative and Qualitative Disclosure about Market Risk 26
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 6. Exhibits 28
SIGNATURES 29
2
PART I - FINANCIAL INFORMATION
ITEM 1 - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UTSTARCOM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
JUNE 30, DECEMBER 31,
2000 1999
--------------------- --------------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 201,663 $ 87,364
Short-term investment 45,390 -
Accounts receivable, net 106,200 77,823
Receivable from related parties 104 339
Inventories, net 86,360 55,204
Other assets 15,045 8,326
--------------------- --------------------
Total current assets 454,762 229,056
Property, plant and equipment, net 10,469 8,168
Investment in affiliated companies 9,056 4,460
Intangible assets, net 22,685 25,132
Deferred tax assets 6,590 4,352
Other long term assets 1,490 620
--------------------- --------------------
Total assets $ 505,052 $ 271,788
===================== ====================
LIABILITIES, MINORITY INTEREST AND
STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 22,616 $ 21,745
Debt 65,674 34,593
Debt to shareholder and related parties - 8,745
Income taxes payable - 2,985
Customer deposits 13,687 5,249
Other liabilities 19,310 29,102
--------------------- --------------------
Total current liabilities 121,287 102,419
--------------------- --------------------
Minority interest in consolidated subsidiaries 4,174 3,649
Stockholders' equity:
Convertible preferred stock: $.00125 par value; authorized: 99,200,000
shares; issued and outstanding 70,377,322; liquidation value of
$259,608 at December 31, 1999 - 88
Common stock: $.00125 par value; authorized: 250,000,000
shares; issued and outstanding: 93,915,105 at June 30, 2000 and
8,929,837 at December 31, 1999 119 13
Common stock warrant - 389
Additional paid-in capital 422,134 218,303
Deferred stock compensation (10,244) (17,792)
Accumulated deficit (31,596) (34,821)
Notes receivable from shareholders (841) (555)
Unrealized losses on investments (66) -
Cumulative translation adjustment 85 95
--------------------- --------------------
Total stockholders' equity 379,591 165,720
--------------------- --------------------
Total liabilities, minority interest, and stockholders' equity $ 505,052 $ 271,788
===================== ====================
See accompanying notes to condensed consolidated financial statements.
3
UTSTARCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
----------------------------- ---------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------- ---------------------------
2000 1999 2000 1999
-------------- ------------ ------------ ------------
(Unaudited) (Unaudited)
Net sales $ 80,008 $ 42,131 $ 138,767 $ 69,682
Cost of sales (excludes stock compensation expense of $23,
$4, $56 and $6) 51,629 23,873 89,495 41,825
-------------- ------------ ------------ ------------
Gross profit 28,379 18,258 49,272 27,857
Operating expenses:
Selling, general and administrative expenses (excludes stock
compensation expense of $1,249, $324, $3,051 and $768) 9,680 8,292 18,942 13,879
Research and development expenses (excludes stock compensation
expense of $660, $346, $5,255 and $501) 8,226 4,138 14,540 8,183
Amortization of deferred stock compensation 1,932 674 8,362 1,275
Amortization of intangible assets 1,224 37 2,447 74
-------------- ------------ ------------ ------------
Total operating expenses 21,062 13,141 44,291 23,411
-------------- ------------ ------------ ------------
Operating income 7,317 5,117 4,981 4,446
Interest income 3,685 399 5,039 982
Interest expenses (949) (660) (1,706) (1,558)
Other income (expenses) 303 (228) 478 (133)
Equity in net income (loss) of affiliated companies (87) 702 (327) 892
-------------- ------------ ------------ ------------
Income before income taxes and minority interest 10,269 5,330 8,465 4,629
Income tax expense (benefit) 3,797 213 4,715 185
-------------- ------------ ------------ ------------
Income before minority interest 6,472 5,117 3,750 4,444
Minority interest in (earnings) of consolidated subsidiaries (264) (103) (525) (589)
-------------- ------------ ------------ ------------
Income from continuing operations 6,208 5,014 3,225 3,855
Loss from discontinued operations - (1,389) - (1,656)
-------------- ------------ ------------ ------------
Net income $ 6,208 $ 3,625 $ 3,225 $ 2,199
============== ============ ============ ============
Basic earnings (loss) per share:
Income from continuing operations $ 0.07 $ 0.58 $ 0.05 $ 0.45
Loss from discontinued operations $ - $ (0.16) $ - $ (0.19)
-------------- ------------ ------------ ------------
Net income - basic earnings per share $ 0.07 $ 0.42 $ 0.05 $ 0.26
============== ============ ============ ============
Diluted earnings (loss) per share:
Income from continuing operations $ 0.06 $ 0.07 $ 0.03 $ 0.05
Loss from discontinued operations $ - $ (0.02) $ - $ (0.02)
-------------- ------------ ------------ ------------
Net income - diluted earnings per share $ 0.06 $ 0.05 $ 0.03 $ 0.03
============== ============ ============ ============
Weighted average shares used in per-share calculation:
- Basic 93,527 8,687 64,697 8,608
============== ============ ============ ============
- Diluted 104,506 73,505 99,846 73,463
============== ============ ============ ============
See accompanying notes to condensed consolidated financial statements.
4
UTSTARCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
SIX MONTHS ENDED
---------------------------------
JUNE 30, JUNE 30,
2000 1999
---------------- ---------------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,225 $ 2,199
Adjustments to reconcile net income to net cash used in operating
activities:
Loss from discontinued operations - 1,656
Depreciation and amortization 4,249 1,427
Net loss on sale and disposal of assets 128 49
Stock compensation expense 8,362 1,275
Equity in net (income) loss of affiliated companies 327 (892)
Minority interest 525 589
Changes in operating assets and liabilities:
Accounts receivable and receivable from related parties (26,252) (4,287)
Inventories (31,157) 1,350
Other current and non-current assets (7,021) (5,810)
Accounts payable and payable to related parties (7,874) (15,091)
Income taxes payable (192) (42)
Other current liabilities (1,354) 9,417
---------------- ---------------
Net cash used in continuing operations (57,034) (8,160)
Net cash used in discontinued operations - (357)
---------------- ---------------
Net cash used in operating activities (57,034) (8,517)
---------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (4,335) (887)
Investment in affiliates, net (4,923) -
Proceeds from disposal of property 103 14
Purchase of short-term investments (45,390) -
---------------- ---------------
Net cash used in investing activities (54,545) (873)
---------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of stock, net of expenses 195,012 45
Proceeds from borrowing, net 31,081 5,660
Proceeds (payments) from shareholder notes, net (139) 3
Unrealized holding (loss) (66) -
---------------- ---------------
Net cash provided by financing activities 225,888 5,708
Effects of exchange rates on cash (10) 1
---------------- ---------------
Net increase (decrease) in cash and cash equivalents 114,299 (3,681)
Less cash used in discontinued operations - (357)
---------------- ---------------
Net increase (decrease) in cash and cash equivalents 114,299 (3,324)
Cash and cash equivalents at beginning of period 87,364 17,626
---------------- ---------------
Cash and cash equivalents at end of period $ 201,663 $ 14,302
================ ===============
See accompanying notes to condensed consolidated financial statements.
5
UTSTARCOM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Information for the three and six months ended June 30, 2000
and June 30, 1999 is unaudited)
1. BASIS OF PRESENTATION:
UTStarcom, Inc. (the Company), a Delaware corporation, provides
communications equipment including network access systems, optical transmission
products and subscriber terminal products for service providers that operate
wireless and wireline networks. The Company's operations are conducted primarily
by its foreign subsidiaries that manufacture, distribute, and support the
Company's products in international markets, principally the People's Republic
of China (China).
The accompanying consolidated financial statements include the accounts
of the Company and its wholly and majority (50 percent or more) owned
subsidiaries, except for the Guangdong manufacturing subsidiary (GUTS) which is
accounted for using the equity method as the Company does not have voting
control over all significant matters. All significant intercompany accounts and
transactions have been eliminated in preparation of the consolidated financial
statements. Minority interest in consolidated subsidiaries and equity in
affiliated companies are shown separately in the consolidated financial
statements. Investments in affiliated companies, of which none represent greater
than 20 percent ownership, are accounted for using the cost method.
The accompanying financial data as of June 30, 2000 and for the three
and six months ended June 30, 2000 and June 30, 1999 have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. The December 31, 1999 balance sheet was derived from audited
financial statements, but does not include all disclosures required by generally
accepted accounting principles. However, the Company believes that the
disclosures are adequate to make the information presented not misleading. These
condensed consolidated financial statements should be read in conjunction with
the Company's audited December 31, 1999 financial statements including the notes
thereto, and the other information set forth therein included in the Company's
Registration Statement on Form S-1.
In the opinion of management, the accompanying condensed consolidated
financial statements reflect all adjustments (consisting of only normal
recurring adjustments) considered necessary for a fair statement of the
Company's financial condition, the results of its operations and its cash flows
for the periods indicated. The results of operations for the three and six
months ended June 30, 2000 are not necessarily indicative of the operating
results for the full year.
2. EARNINGS (LOSS) PER SHARE:
Basic and diluted earnings per share are computed in accordance with
Statement of Financial Accounting Standards No. 128 ("SFAS 128"). Basic earnings
per share is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted
earnings per share is computed giving effect to all dilutive potential common
shares that were outstanding during the period. Dilutive potential common shares
consist of the incremental common shares issuable upon the conversion of
convertible preferred stock (using the "if converted" method) and exercise of
stock options and warrants for all periods. Dilutive potential common shares are
not included during periods in which the Company experienced a net loss, as the
impact would be anti-dilutive.
6
The following table presents the calculation of basic and diluted
earnings (loss) per share:
THREE MONTHS PERIOD ENDED SIX MONTHS PERIOD ENDED
----------------------------------------- --------------------------------------
JUNE 30, 2000 JUNE 30, 1999 JUNE 30, 2000 JUNE 30, 1999
------------- ------------- ------------- -------------
(UNAUDITED) (UNAUDITED)
Numerator:
Income from continuing operations $ 6,208 $ 5,014 $ 3,225 $ 3,855
Loss from discontinued operations $ - $ (1,389) $ - $ (1,656)
---------------- -------------------- ----------------- -----------------
Net income $ 6,208 $ 3,625 $ 3,225 $ 2,199
================ ==================== ================= =================
Denominator:
Weighted-average shares outstanding - basic 93,527 8,687 64,697 8,608
Weighted-average shares outstanding - diluted 104,506 73,505 99,846 73,463
Basic earnings (loss) per share:
Income from continuing operations $ 0.07 $ 0.58 $ 0.05 $ 0.45
(Loss) from discontinued operations $ - $ (0.16) $ - $ (0.19)
---------------- -------------------- ----------------- -----------------
$ 0.07 $ 0.42 $ 0.05 $ 0.26
================ ==================== ================= =================
Diluted earnings (loss) per share:
Income from continuing operations $ 0.06 $ 0.07 $ 0.03 $ 0.05
(Loss) from discontinued operations $ - $ (0.02) $ - $ (0.02)
---------------- -------------------- ----------------- -----------------
$ 0.06 $ 0.05 $ 0.03 $ 0.03
================ ==================== ================= =================
3. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION (IN THOUSANDS):
SIX MONTHS PERIOD ENDED
JUNE 30,
--------
2000 1999
---- ----
(UNAUDITED)
Cash paid during the period for:
Interest $ 1,501 $ 2,179
Income taxes $ 4,779 $ 331
Noncash investing and financing activities were as follows:
SIX MONTHS PERIOD ENDED
JUNE 30,
--------
2000 1999
---- ----
(UNAUDITED)
Distribution of net assets to shareholders $ - $ 369
Receivable from shareholders $ 147 $ -
Non-qualified stock option exercise tax benefits $7,737 $ -
4. CASH, CASH EQUIVALENTS AND INVESTMENTS
The Company considers all highly liquid monetary instruments with an
original maturity of three months or less at the date of purchase to be cash
equivalents. Short-term investments consist primarily of investments with
original maturities of less than twelve months.
Pursuant to Statement of Financial Accounting Standards No. 115 ("SFAS
No. 115"), "Accounting for Certain Investments in Debt and Equity Securities"
debt securities that the Company does not have the positive intent and ability
to hold to maturity and all marketable equity securities are classified as
available-for-sale and are carried at fair value. Unrealized holding gains and
losses on securities classified as available-for-sale are carried as a separate
component of stockholders' equity. Unrealized holdings gains and losses on
securities classified as available-for-sale are reported as earnings. The fair
value of investments is determined based upon
7
quoted market prices. The cost of debt securities is adjusted for amortization
of premiums and accretion of discounts to maturity. Such amortization, interest
income, realized gains and losses and declines in value judged to be other than
temporary are included in interest and other income. The cost of securities is
based on specific identification.
All of the Company's cash equivalents and short-term investments are
classified as available-for-sale. At June 30, 2000, $157.4 million of
available-for-sale securities were included in cash equivalents and $45.4
million of available-for-sale securities were included in short-term
investments. These available-for-sale securities consisted of government
sponsored entities notes, commercial paper, floating rate corporate bonds and
fixed income corporate bonds.
5. DEBT TO SHAREHOLDERS (IN THOUSANDS):
Payable to related parties and debt to shareholder as of June 30, 2000
and December 31, 1999 consist of the following:
JUNE 30, 2000 DECEMBER 31, 1999
-------------------- -----------------------------
(UNAUDITED)
Debt to shareholder-SOFTBANK $ -- $ 8,745
6. DEBT (IN THOUSANDS):
The following represents the outstanding borrowings at June 30, 2000 and
December 31, 1999:
JUNE 30, DECEMBER 31,
NOTE RATE MATURITY 2000 1999
- ---- ---- -------- ---- ----
(UNAUDITED)
Bank of China(1) From 5.58% to 5.86% From 7/00 to 06/01 $33,134 $27,108
China Merchants Bank(2) 6.44% 03/01 3,614 -
Commercial Bank of Hangzhou(3) 6.44% 10/00 6,024 6,024
Commercial Bank of Hangzhou(4) 5.86% 03/01 12,048 -
Industrial & Commercial Bank of 5.85% 05/01 6,024 1,446
China(5)
China Construction Bank (6) 6.44% 06/01 4,819 -
Other Various Various 11 15
-------------------------------------------------------------------------------------
Total debt $65,674 $34,593
======================================
- -----------
(1) Guaranteed by the Company and the minority shareholder of Zhejiang
manufacturing subsidiary (HUTS). This represents drawings on the
Company's line of credit with the bank. This line allows for borrowings
of up to $90,361.
(2) Collateralized by $1,500 deposited with the bank and guaranteed by
HUTS. This line allows for borrowings of up to $3,614 and matures on
March 1, 2001.
(3) Guaranteed by HUTS. This line allows for borrowings of up to $6,024 and
matures in October 2000.
(4) Guaranteed by UTStarcom-China. This line allows for borrowings of up to
$12,048 and matures in March 2001.
(5) Guaranteed by HUTS. This line allows for borrowings of up to $6,024 and
matures in May 2001.
(6) Guaranteed by HUTS. This line allows for borrowings of up to $4,819 and
matures in June 2001
7. FORWARD FOREIGN EXCHANGE CONTRACT:
8
The Company has contracts denominated in Japanese Yen to purchase
portions of its inventories and supplies. As such, it is exposed to adverse
movements in the currency exchange rate for Japanese Yen. The Company enters
into forward foreign exchange contracts to reduce such foreign exchange
exposures.
The Company has adopted Statement of Financial Accounting Standard No.
52 ("SFAS 52"), "Accounting for Foreign Currency Translation" to account for its
forward foreign exchange contract transaction. SFAS 52 states that gains or
losses on forward contracts shall be deferred and included in the measurement of
the related foreign currency transactions. As of June 30, 2000, the Company had
a forward contract to hedge Japanese Yen valued at $3.8 million and deferred
gains and losses related to this forward contract were not material.
8. COMPREHENSIVE INCOME (LOSS) :
The Company's total comprehensive net income was as follows (in
thousands):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2000 1999 2000 1999
---- ---- ---- ----
(Unaudited) (Unaudited)
Net income $ 6,208 $ 3,625 $ 3,225 $ 2,199
Change in cumulative translation adjustments (439) - (10) -
Unrealized losses on investments (66) - - -
------------------------------- ---------------------------
Total comprehensive income $ 5,703 $ 3,625 $ 3,215 $ 2,199
=============================== ===========================
9. INITIAL PUBLIC OFFERING:
On March 3, 2000, the Company sold 11,500,000 shares of common stock
including the exercise of the underwriters' over-allotment option at $18.00 per
share. The sale of the shares of common stock generated aggregate gross proceeds
of approximately $207.0 million for the Company. The aggregate net proceeds were
approximately $189.4 million, after deducting underwriting discounts and
commissions and related expenses. As of the effective date of the offering, all
of the convertible preferred stock outstanding was converted into 70,377,322
shares of common stock. The net proceeds are expected to be used for general
corporate purposes, including working capital and capital expenditures. A
portion of the net proceeds may also be used to acquire or invest in
complementary businesses, technologies or product offerings; however, there are
no current material agreements or commitments with respect to any such
activities.
10. RECENT ACCOUNTING PRONOUNCEMENTS:
In April 2000, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25". This Interpretation
clarifies the application of Opinion 25 for certain stock compensation issues
including the definition of employee for purposes of applying Opinion 25, the
criteria for determining whether a plan qualifies as a noncompensatory plan, the
accounting consequence of various modifications to the terms of a previously
fixed stock option, and the accounting for an exchange of stock compensation
9
awards in a business combination. This Interpretation is effective July 1, 2000.
UTStarcom does not expect the adoption of FASB Interpretation No. 44 to have a
significant effect on the financial condition or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance on the recognition, presentation, and
disclosure of revenue in the financial statements. All registrants are expected
to apply the accounting and disclosures described in SAB 101. Implementation of
SAB101 has been delayed by the Securities and Exchange Commision until the
fourth fiscal quarter of fiscal years beginning after December 15, 1999. Because
the Company has complied with generally accepted accounting principles for its
historical revenue recognition, a change, if any, in its revenue recognition
policy resulting from SAB 101 will be reported as a change in accounting
principle in the quarter ended December 31, 2000 and may require a cumulative
adjustment as of the beginning of the first quarter of 2001. The Company is
waiting for further guidance from the Securities and Exchange Commission before
completing its assessment of the impact of SAB 101, as amended, on its financial
statements. The Company is in the process of revising its standard contracts so
that the impact of SAB101 on the timing of revenue recognition is minimized in
the future.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting for Derivatives and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. In July 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133." SFAS No. 137 deferred the effective date of SFAS No.
133 until fiscal years beginning after June 15, 2000. UTStarcom will adopt SFAS
No. 133 during its year ending December 31, 2001. UTStarcom is unable to predict
the impact of adopting SFAS No. 133.
11. COUNTRY RISKS:
Almost 99% of our sales for the three and six months ended June 30,
2000 were made in China. Accordingly, our business, financial condition and
results of operations may be influenced by the political, economic and legal
environment in China, and by the general state of China's economy. Our
operations in China are subject to special considerations and significant risks
not typically associated with companies in the United States. These include
risks associated with, among others, the political, economic and legal
environments and foreign currency exchange. Our results may be adversely
affected by, among other things, changes in the political, economic and social
conditions in China, and by changes in governmental policies with respect to
laws and regulations, changes in China's telecommunications industry and
regulatory rules and policies, anti-inflationary measures, currency conversion
and remittance abroad, and rates and methods of taxation.
Beginning in January 1, 1999, China's government required that all
manufacturers of telecommunications equipment connected to public or private
telecommunications networks within China obtain a network access license for
each of its products. Sellers are prohibited from selling or advertising for
sale equipment for which its manufacturer has not obtained a network access
license and may be liable for penalties in an amount up to three times revenue
from the sale of any equipment sold beginning January 1, 1999 without a license.
Failure to obtain the required licenses could permit the authorities to force
the Company to remove previously installed equipment and could preclude the
Company from making further sales of the unlicensed products in China, which
would substantially harm the Company's business.
Management has applied for network access licenses for the Airstar
system and for other products which the Company is no longer manufacturing
but had previously sold. However, the Company has not yet received these
access licenses and has no any assurance that a license will be issued.
Management believes that no penalties or fines will be payable for
non-compliance with these licensing requirements and that there will be no
adverse effect on the Company's business or financial condition.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
10
This report contains forward-looking statements, which reflect the
Company's current views with respect to future events, which may impact the
Company's results of operations and financial condition. In this report, the
words "anticipates", "believes", "expects", "intends", "future" and similar
expressions identify forward-looking statements. These forward-looking
statements are subject to risks and uncertainties and other factors, including
without limitation those set forth below under the caption "Factors Which May
Affect Future Results," which could cause actual future results to differ
materially from historical results or those described in the forward-looking
statements. The forward-looking statements contained in this report should be
considered in light of these and other factors. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date hereof.
OVERVIEW
We provide communications equipment for service providers that operate
wireless and wireline networks in rapidly growing communications markets. Our
integrated suite of network access systems, optical transmission products and
subscriber terminal products allows service providers to offer efficient and
scalable voice, data and Internet access services. Service providers can easily
integrate our standards-based systems into their existing networks and deploy
our systems in new broadband, IP-based and wireless network rollouts. To date,
substantially all of our sales have been to service providers in China.
We incorporated in Delaware as Unitech Industries Inc. in 1991. Since
our incorporation, we have focused our resources on developing products for
China's communications market. We shipped our first network access products in
1993. In 1994, we changed our name to Unitech Telecom, Inc. In 1995, we acquired
StarCom Network Systems, Inc. and changed our name to UTStarcom, Inc. During
1996, we introduced our advanced, V5.1 and V5.2 compliant, multi-service network
access product, the AN-2000. Late in 1996, we introduced our Airstar wireless
access system. In December 1999, we completed the acquisition of Wacos, Inc., a
research and development subsidiary that develops IP-based switching systems. As
part of our business operations in China, we have established a wholly owned
subsidiary and three joint ventures in that country.
To date, we have derived substantially all of our revenues from sales
of communications equipment to service providers in China. Each of the Posts and
Telecommunication Bureaus (PTBs) to whom we sell our equipment in China is part
of the China Telecom system and subject to its ultimate control. However,
equipment purchasing decisions are generally made at the individual PTB level.
Our customers often make a large initial purchase of our equipment followed by
supplemental purchases of enhancements and upgrades. As a result, our largest
revenue-producing customers typically vary from period-to-period.
Almost 99% of our sales for the three months ended June 30, 2000 were
made in China. Accordingly, our business, financial condition and results of
operations may be influenced by the political, economic and legal environment in
China, and by the general state of China's economy. Our operations in China are
subject to special considerations and significant risks not typically associated
with companies in the United States. These include risks associated with, among
others, the political, economic and legal environments and foreign currency
exchange. Our results may be adversely affected by, among other things, changes
in the political, economic and social conditions in China, and by changes in
governmental policies with respect to laws and regulations, changes in China's
telecommunications industry and regulatory rules and policies, anti-inflationary
measures, currency conversion and remittance abroad, and rates and methods of
taxation.
Specifically, remittances from China which are of a capital nature,
such as the repayment of bank loans denominated in foreign currencies, require
approval from appropriate governmental authorities before Renminbi can be used
to purchase foreign currency. Although the payment of cash dividends is
permitted so long as our subsidiaries have sufficient reserves and adequate
amounts of Renminbi to purchase foreign currency, regulations restrict the
ability of our subsidiaries to transfer funds to us through intercompany loans
and advances.
We sell our products in China through a direct sales force. The
evaluation period for our products may span a year or more. Revenue from product
sales is recognized when title is passed and all significant contractual
obligations have been satisfied and collection of the resulting receivable is
reasonably assured. Title passes on customer acceptance.
Cost of sales consists primarily of material costs, third party
commissions, costs associated with assembly and testing of products, costs
associated with installation and customer training and overhead and warranty
costs. Cost of sales also includes import taxes on components.
Our gross profit has been affected by material costs, product mix,
average selling prices, and the type of distribution channel through which we
sell our products. Our gross profit, as a percentage of net sales, varies among
our product families. The gross profits, as a percentage of net sales, on our
mobile phone handsets are very low. We expect that our overall gross profit, as
a percentage of net sales, will fluctuate from period to period as a result of
shifts in product mix, anticipated decreases in average selling prices and our
ability to reduce product costs.
11
Selling, general and administrative expenses include compensation and
benefits, professional fees, sales commissions, provision for uncollectible
accounts receivable and travel and entertainment costs. We intend to pursue
aggressive selling and marketing campaigns and to expand our direct sales
organization and, as a result, our sales and marketing expenses will increase in
future periods. We also expect that in support of our continued growth and our
operations as a public company general and administrative expenses will continue
to increase for the foreseeable future.
Research and development expenses consist primarily of salaries and
related costs of employees engaged in research, design and development
activities, the cost of parts for prototypes, equipment depreciation and third
party development expenses. We believe that continued investment in research and
development is critical to our long-term success. Accordingly, we expect that
our research and development expenses will increase in future periods.
In connection with the grant of stock options to some of our
employees, we recorded net deferred compensation of $15.9 million during 1999
and $2.9 million during the six months ended June 30, 2000, representing the
difference between the deemed fair value of common stock for accounting
purposes and the option exercise price for these options at the date of
grant. In connection with grants to non-employees during 1999, we recorded
deferred compensation of $7.4 million. Deferred compensation is presented as
a reduction of stockholders' equity, with amortization recorded over the
vesting period of the option, which is generally four years. We recorded
stock compensation expense of approximately $5.6 million during 1999 and $8.4
million during the six months ended June 30, 2000. At June 30, 2000,
approximately $10.2 million remained to be amortized.
Amortization of intangible assets consists primarily of the
amortization of intangible assets associated with acquisitions in China and our
acquisition of the minority interest in our Wacos, Inc. subsidiary.
Consolidated equity in net income (loss) of affiliated companies
comprises our share of the earnings from our Guangdong manufacturing subsidiary.
Under current regulations in China, foreign investment enterprises that
have been accredited as technologically advanced enterprises are entitled to
additional tax incentives. These tax incentives vary in different locales and
could include preferential national enterprise income tax treatment at 50% of
the usual rates for different periods of time. All of our active subsidiaries in
China were accredited as technologically advanced enterprises.
Minority interest in (earnings) loss of consolidated subsidiaries
represents the share of earnings in our Zhejiang manufacturing joint venture
that is owned by our subsidiary partner.
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2000 AND 1999
NET SALES. Our net sales increased 89.9% from $42.1 million for the
three months ended June 30, 1999 to $80.0 million for the corresponding period
in 2000. This increase was primarily due to an increase in sales volume of our
Airstar system. For the three months ended June 30, 2000, sales to Hangzhou PTB
and Baoding PTB accounted for 17.1% and 11.5% of our net sales, respectively.
For the three months ended June 30, 1999, sales to Kunming PTB accounted for
41.8% of our net sales.
GROSS PROFIT. Gross profit increased 55.4% from $18.3 million for the
three months ended June 30, 1999 to $28.4 million for the corresponding period
in 2000. Gross profit, as a percentage of net sales, decreased from 43.3% for
the three months ended June 30, 1999 to 35.5% for the three months ended June
30, 2000. The decrease in gross profit, as a percentage of net sales, was
primarily due to increases in sales of lower margin handsets.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses increased 16.7% from $8.3 million for the three months
ended June 30, 1999 to $9.7 million for the corresponding period in 2000. The
increase in selling, general and administrative expenses was primarily due to
increased sales and administrative personnel and related expenses associated
with the growth in net sales and the expansion of our overall level of business
activities. Selling, general and administrative expenses as a percentage of net
sales decreased from 19.7% for the three months ended June 30, 1999 to 12.1% for
the corresponding period in 2000. The decrease in selling, general and
administrative expenses as a percentage of net sales was primarily due to
economies of scale associated with the significant increases in net sales. We
expect our selling, general and administrative expenses to increase in absolute
dollar amounts in future periods as sales and marketing activities increase and
we further invest in infrastructure and incur additional expenses related to
anticipated growth of our business and operation as a publicly held company.
12
RESEARCH AND DEVELOPMENT Research and development expenses increased
98.8% from $4.1 million for the three months ended June 30, 1999 to $8.2 million
for the corresponding period in 2000. The increase in research and development
expenses was primarily due to the hiring of additional technical personnel and
increased prototype expenses and licensing fees to support our research and
development efforts. As a percentage of net sales, research and development
expenses increased from 9.8% for the three months ended June 30, 1999 to 10.3%
for the corresponding period in 2000. We expect our research and development
expenses to increase in absolute dollar amounts in future periods as we expand
our research and development organization to support new product development.
STOCK COMPENSATION EXPENSE Stock compensation expense increased from
$0.7 million for the three months ended June 30, 1999 to $1.9 million for the
corresponding period in 2000. The expense is related to certain stock option
grants to employees and non-employees which we are amortizing over the vesting
periods of the applicable options.
AMORTIZATION OF INTANGIBLE ASSETS Amortization of intangible assets
increased from $37,000 for the three months ended June 30, 1999 to $1.2 million
for the corresponding period in 2000. The increase in amortization of intangible
assets was due to the increase in amortization associated with our December 1999
acquisition of the portion of our Wacos, Inc. subsidiary owned by the minority
shareholders.
INTEREST INCOME (EXPENSES), NET Net interest expenses were $0.3 million
for the three months ended June 30, 1999 and net interest income was $2.7
million for the corresponding period in 2000. The increase in interest income
was primarily due to increased interest income from higher average cash
balances.
OTHER INCOME (EXPENSES), NET Other expense was $0.2 million for the
three months ended June 30, 1999 and other income was $0.3 million for the
corresponding period in 2000. The increase in other income was primarily due to
gain on settlement of forward foreign exchange contract.
EQUITY IN INCOME (LOSS) OF AFFILIATED COMPANIES Consolidated equity in
net income of affiliated companies was $0.7 million for the three months ended
June 30, 1999 and consolidated equity in net loss of affiliated companies was
$0.1 million for the corresponding period in 2000. The change between the two
periods was primarily due to the decrease of net income at our Guangdong
manufacturing subsidiary.
INCOME TAX EXPENSE Income tax expense was $213,000 for the three months
ended June 30, 1999 and income tax expenses were $3.8 million for the
corresponding period in 2000. The increase in the income tax expenses was due to
our increasing income.
MINORITY INTEREST IN EARNINGS OF CONSOLIDATED SUBSIDIARIES Minority
interest in earnings of consolidated subsidiaries was $0.1 million for the three
months ended June 30, 1999 and $0.3 million for the corresponding period in
2000. The change between the two periods was primarily due to the increased
profitability at our Zhejiang subsidiary.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999
NET SALES. Our net sales increased 99.1% from $69.7 million for the six
months ended June 30, 1999 to $138.8 million for the corresponding period in
2000. This increase was primarily due to an increase in sales volume of our
Airstar system. For the six months ended June 30, 2000, sales to Hangzhou PTB
accounted for 26.6% of our net sales. For the six months ended June 30, 1999,
sales to Kunming PTB and Baoding PTB accounted for 25.9% and 13.5% of our net
sales, respectively.
GROSS PROFIT. Gross profit increased 76.9% from $27.9 million for the
six months ended June 30, 1999 to $49.3 million for the corresponding period in
2000. Gross profit, as a percentage of net sales, decreased from 40.0% for the
six months ended June 30, 1999 to 35.5% for the six months ended June 30, 2000.
The decrease in gross profit, as a percentage of net sales, was primarily due to
increases in sales of lower margin handsets.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses increased 36.5% from $13.9 million for the six months
ended June 30, 1999 to $18.9 million for the corresponding period in 2000. The
increase in selling, general and administrative expenses was primarily due to
increased sales and administrative personnel and related expenses associated
with the growth in net sales and the expansion of our overall level of business
activities. Selling, general and administrative expenses as a percentage of net
sales decreased from 19.9% for the six months ended June 30, 1999 to 13.7% for
the corresponding period in 2000. The decrease in selling, general and
administrative expenses as a percentage of net sales was primarily due to
economies of scale associated with the significant increases in net sales. We
expect our selling, general and administrative expenses to increase in absolute
dollar amounts in future periods as sales and marketing activities increase and
we further invest in infrastructure and incur additional expenses related to
anticipated growth of our business and operation as a publicly held company.
13
RESEARCH AND DEVELOPMENT Research and development expenses increased
77.7% from $8.2 million for the six months ended June 30, 1999 to $14.5 million
for the corresponding period in 2000. The increase in research and development
expenses was primarily due to the hiring of additional technical personnel and
increased prototype expenses and licensing fees to support our research and
development efforts. As a percentage of net sales, research and development
expenses decreased from 11.7% for the six months ended June 30, 1999 to 10.5%
for the corresponding period in 2000. We expect our research and development
expenses to increase in absolute dollar amounts in future periods as we expand
our research and development organization to support new product development.
STOCK COMPENSATION EXPENSE Stock compensation expense increased from
$1.3 million for the six months ended June 30, 1999 to $8.4 million for the
corresponding period in 2000. The expense is related to certain stock option
grants to employees and non-employees which we are amortizing over the vesting
periods of the applicable options.
AMORTIZATION OF INTANGIBLE ASSETS Amortization of intangible assets
increased from $74,000 for the six months ended June 30, 1999 to $2.4 million
for the corresponding period in 2000. The increase in amortization of intangible
assets was due to the increase in amortization associated with our December 1999
acquisition of the portion of our Wacos, Inc. subsidiary owned by the minority
shareholders.
INTEREST INCOME (EXPENSES), NET Net interest expenses were $0.6 million
for the six months ended June 30, 1999 and net interest income was $3.3 million
for the corresponding period in 2000. The increase in interest income was
primarily due to increased interest income from higher average cash balances.
OTHER INCOME (EXPENSES), NET Other expense was $0.1 million for the six
months ended June 30, 1999 and other income was $0.5 million for the
corresponding period in 2000. The increase in other income was primarily due to
gain on settlement of forward foreign exchange contract and dividend income from
our investment in affiliated companies.
EQUITY IN INCOME (LOSS) OF AFFILIATED COMPANIES Consolidated equity in
net income of affiliated companies was $0.9 million for the six months ended
June 30, 1999 and consolidated equity in net loss of affiliated companies was
$0.3 million for the corresponding period in 2000. The change between the two
periods was primarily due to the decrease of net income at our Guangdong
manufacturing subsidiary.
INCOME TAX EXPENSE Income tax expense was $185,000 for the six months
ended June 30, 1999 and income tax expenses were $4.7 million for the
corresponding period in 2000. The increase in the income tax expenses was due to
our increasing income.
MINORITY INTEREST IN EARNINGS OF CONSOLIDATED SUBSIDIARIES Minority
interest in earnings of consolidated subsidiaries was $0.6 million for the six
months ended June 30, 1999 and $0.5 million for the corresponding period in
2000. The change between the two periods was primarily due to the decreased
profitability at our Zhejiang subsidiary.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations through the sales of preferred stock,
bank lines of credit and our initial public offering in March 2000. In November
and December 1999, we secured private equity financing totaling $55.0 million.
In March, 2000, we raised $189.4 million in net proceeds from our initial public
offering. As of June 30, 2000, we had working capital of $333.5 million,
including $201.7 million in cash and cash equivalents, $45.4 million of short
term investments and $65.7 million of Renminbi-denominated bank borrowings.
We have invested $5.0 million and may invest up to an additional
$10.0 million in an investment fund to be established by SOFTBANK focused on
investments in Internet companies in China. Our investment will constitute
10% of the funding for the SOFTBANK investment fund, with SOFTBANK
contributing the remaining 90%. We will be a passive investor and have no
decision-making authority with respect to investments by the fund. The fund
will have a separate management team, and none of our employees will be
employed by the fund. One of our directors will serve as the Chief Executive
Officer of the fund, and our Chief Executive Officer will be chairman of the
board of the fund. We will not be obligated to pay, nor will we receive, any
fees in connection with services provided to the fund. We do not know what
material fees will be paid to or by SOFTBANK or any other parties in
connection with services provided to the fund.
Net cash used in operations for the six months ended June 30, 2000 of
$57.0 million was primarily due to an increase in inventories, accounts
receivable and other current and non-current assets of $31.2 million, $26.3
million and $7.0 million, respectively, and a decrease in accounts payable of
$7.9 million. The uses of cash were partially offset by depreciation and
amortization expense of $4.2 million and amortization of deferred stock
compensation expense of $8.4 million.
14
Net cash used in investing activities for the six months ended June 30,
2000 of $54.5 million was primarily due to acquisition of property, plant and
equipment of $4.3 million, our $5 million investment in SOFTBANK investment
fund, and the purchase of short-term investments of $45.4 million.
Net cash provided by financing activities for the six months ended
June 30, 2000 of $225.9 million was primarily due to net proceeds of $189.4
million from the issuance of common stock through our initial public offering,
and net proceeds of $31.1 million from borrowing under our lines of credit.
Our international sales are generally denominated in local currencies.
Due to the limitations on converting Renminbi, we are limited in our ability to
engage in currency hedging activities in China. Although the impact of currency
fluctuations to date has been insignificant, we cannot guarantee that
fluctuations in currency exchange rates in the future will not have a material
adverse effect on revenues from international sales and, correspondingly, on our
business, financial condition and results of operations. We also have contracts
negotiated in Japanese Yen for purchasing portions of our inventories and
supplies. We have entered into foreign currency hedging transactions to reduce
exposure to foreign exchange risks. As of June 30, 2000, we had a forward
contract to hedge Japanese Yen valued at $3.8 million. The contract was entered
into on February 22, 2000.
We believe that our existing cash and cash equivalents, short-term
investments and cash from operations will be sufficient to finance our
operations through at least the next 12 months. If additional financing is
needed, there can be no assurance that such financing will be available to us
on commercially reasonable terms, or at all.
FACTORS AFFECTING FUTURE OPERATING RESULTS
OUR FUTURE SALES ARE UNPREDICTABLE, OUR OPERATING RESULTS ARE LIKELY TO
FLUCTUATE FROM QUARTER TO QUARTER, AND IF WE FAIL TO MEET THE EXPECTATIONS OF
SECURITIES ANALYSTS OR INVESTORS, OUR STOCK PRICE COULD DECLINE SIGNIFICANTLY
Our quarterly and annual operating results have fluctuated in the past
and are likely to fluctuate in the future due to a variety of factors, some of
which are outside of our control. As a result, period to period comparisons of
our operating results are not necessarily meaningful or indicative of future
performance. Furthermore, it is likely that in some future quarters our
operating results will fall below the expectations of securities analysts or
investors. If this occurs, the trading price of our common stock could decline.
Factors that may affect our future operating results include:
- the timing, number and size of orders for our products, as well as
the relative mix of orders for each of our products, particularly
the volume of lower margin telephone handsets;
- the evolving and unpredictable nature of the economic, regulatory
and political environments in China and other countries in which
we market or plan to market our products;
- aggressive price reductions by our competitors;
- currency fluctuations;
- market acceptance of our products and product enhancements;
- the lengthy and unpredictable sales cycles associated with sales
of our products combined with the impact of this variability on
our suppliers' ability to provide us with components on a timely
basis; and
- longer collection periods of accounts receivable in China and
other countries.
The limited performance history of some of our products, our limited
forecasting experience and processes and the emerging nature of our target
markets make forecasting our future sales and operating results difficult. Our
expense levels are based, in part, on our expectations regarding future sales,
and these expenses are largely fixed, particularly in the short term. In
addition, to enable us to promptly fill orders, we maintain inventories of
finished goods, components and raw materials. As a result, we commit to
considerable costs in advance of anticipated sales. In the past, a substantial
portion of our sales in each quarter resulted from orders received and shipped
in that quarter, and we have operated with a limited backlog of unfilled orders.
Accordingly, we may not be
15
able to reduce our costs in a timely manner to compensate for any unexpected
shortfall between forecasted and actual sales. Any significant shortfall of
sales may require us to maintain higher levels of inventories of finished goods,
components and raw materials than we require, thereby increasing our risk of
inventory obsolescence and corresponding inventory write-downs and write-offs.
Although we have reserved against inventory obsolescence, we cannot guarantee
that these reserves will be adequate to offset all write-downs or write-offs.
WE HAVE A HISTORY OF LOSSES AND AN ACCUMULATED DEFICIT
As of June 30, 2000, we had an accumulated deficit of approximately
$31.6 million. We anticipate continuing to incur significant sales and
marketing, research and development and general and administrative expenses and,
as a result, we will need to generate higher revenues to sustain profitability.
Numerous factors could negatively impact our results of operations, including a
decrease in sales, price pressures and a fixed cost structure which could limit
our ability to respond to declining revenues. Although our sales have grown in
recent quarters, our past results should not be relied on as indications of our
future performance. We cannot assure you that we will be able to remain
profitable in future periods.
COMPETITION IN OUR MARKETS MAY LEAD TO REDUCED PRICES, REVENUES AND MARKET SHARE
We face intense competition in our target markets and expect
competition to increase. Increased competition in our target markets may result
in price reductions, reduced gross profit as a percentage of net sales and loss
of market share. Our principal competitors for our different product lines
include the following:
- AIRSTAR SYSTEM: Alcatel Alsthom CGE, S.A.; Ericsson LM Telephone Co.;
Huawei Technology Co., Ltd.; Lucent Technologies, Inc.; Motorola, Inc.;
NEC Corporation; Siemens AG; and Zhongxing Telecommunications
Equipment.
- AN-2000 AND OMUX: Advanced Fibre Communications, Inc.; Alcatel; Bosch
Telecom GmbH; ECI Telecom Ltd.; Ericsson; Fujitsu Limited; Huawei;
Lucent; NEC; Nokia Corporation; Shanghai Bell Alcatel Mobile
Communication; Siemens; and Zhongxing.
- WACOS SYSTEM: Alcatel; Cisco Systems, Inc.; Clarent Corporation;
Ericsson; Huawei; Lucent; Motorola; Nokia; Nortel Networks Corporation;
Nuera Communications, Inc.; Siemens; Tachion Networks, Inc.; and Vienna
Systems Corp.
We are increasingly facing competition from domestic companies in China
and believe that our strongest competition in the future may come from these
companies, many of which operate under lower cost structures and more favorable
governmental policies and with much larger sales forces than we do. Furthermore,
other companies not presently offering competing products may also enter our
target markets. Many of our competitors have significantly greater financial,
technical, product development, sales, marketing and other resources than we do.
Additionally, some competitors may be able to offer significant financing
arrangements to service providers, in some cases facilitated by favorable
government policies. Moreover, current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties, including our current customers, to increase their ability to
produce products that address the needs of service providers in our target
markets.
THE SUCCESS OF OUR BUSINESS DEPENDS ON A RELATIVELY SMALL NUMBER OF LARGE SYSTEM
DEPLOYMENTS, AND ANY CANCELLATION, REDUCTION OR DELAY IN THESE DEPLOYMENTS COULD
HARM OUR BUSINESS
Our business is characterized by large system deployments for a
relatively small number of service providers. In the three months ended June 30,
2000, one customer accounted for 17.1% of our net sales. Our dependence on large
system deployments makes our ability to provide systems in a timely and
cost-effective manner critically important to our business. We have in the past
experienced delays and encountered other difficulties in the installation and
implementation of our systems. Various factors could cause future delays,
including technical problems and the shortage of qualified technicians. Any
delays or difficulties in deploying our systems, or the cancellation of any
orders by service providers, could significantly harm our business.
WE DO NOT HAVE SOME OF THE LICENSES WE REQUIRE TO SELL OUR NETWORK ACCESS
PRODUCTS IN CHINA
Beginning January 1, 1999, China's government required that all
telecommunications equipment connected to public or private telecommunications
networks within China be approved by the Ministry of Information Industry and
the manufacturer of the equipment obtain a network access license for each of
its products. Sellers are prohibited from selling or advertising for sale
equipment for which its manufacturer has not obtained a network access license
and may be liable for penalties in an amount up to three times earnings from the
16
sale of any equipment sold beginning January 1, 1999 without a license. In
addition, any unlicensed equipment may be required to be removed from the
network. Failure to obtain the required licenses could require us to remove
previously installed equipment and would prohibit us from making further sales
of the unlicensed products in China, which would substantially harm our
business.
The regulations implementing these requirements are not very detailed,
have not been applied by a court and may be interpreted and enforced by
regulatory authorities in a number of different ways. Accordingly, we have
obtained an opinion from our counsel in China as to which licenses we are
required to obtain. Based upon this counsel's advice, we believe that we have
obtained the required network access licenses for our AN-2000 system, bundled
OMUX product and standard OMUX product. We have applied for a network access
license for our Airstar system. In June, 2000 the Ministry of Information
Industry issued an internal notice concluding its review of PHS-based equipment.
Our Airstar system will continue to be allowed in China's county-level cities
and counties, which are our primary markets for our Airstar system. In large and
medium-sized cities, our Airstar system may be used on a limited basis where
there is a high concentration of population, such as campuses, commercial
buildings and special development zones. New city-wide Airstar system
deployments will not be allowed in large and medium-size cities. The evaluation
group for access networks under the Ministry of Information Industry has
recommended that the Ministry of Information Industry issue a license for our
Airstar system. However, we do not yet have this network access license and we
cannot provide any assurance that such a license will be issued for our Airstar
system. We have also applied for network access licenses for other products
which we are no longer manufacturing but had previously sold to service
providers in China. Network access licenses will be required for any additional
products that we may develop for sale in China, including our WACOS system.
Based upon verbal inquiries made by our counsel in China to the Ministry of
Information Industry, we believe that for products which we sold before January
1, 1999, such as the Airstar system, no penalties will be imposed by the
Ministry of Information Industry for sales we have made or will make during the
period in which an application for a network access license is pending. However,
our counsel in China has advised us that China's governmental authorities may
interpret or apply the regulations with respect to which licenses are required
and the ability to sell a product while an application for a network access
license is pending in a manner that is inconsistent with the verbal
representation received by our counsel in China, either of which could have a
material adverse effect on our business and financial condition.
OUR BUSINESS MAY SUFFER IF WE ARE UNABLE TO COLLECT PAYMENTS FROM OUR CUSTOMERS
ON A TIMELY BASIS
Our customers often must make a significant commitment of capital to
purchase our products. As a result, any downturn in a customer's business that
affected the customer's ability to pay us could harm our financial condition.
Moreover, accounts receivable collection cycles historically tend to be much
longer in China than in other markets. The failure of any of our customers to
make timely payments could require us to write-off accounts receivable or
increase our accounts receivable reserves, either of which could adversely
affect our financial condition.
A DECLINE IN BUSINESS ACTIVITY DURING CHINA'S LUNAR NEW YEAR MAY RESULT IN
DECREASED SALES DURING OUR FIRST QUARTER
Business activity in China declines considerably during the first
quarter of each year in observance of the Lunar New Year. As a result, sales
during the first quarter of our fiscal year have in the past typically been
lower than sales during the fourth quarter of the preceding year and we expect
this trend to continue in the future. We will continue to face this seasonality
in the future and do not have the ability to forecast with any degree of
certainty the impact of the decreased business activity during the Lunar New
Year on our sales and operating results.
OUR MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE, AND TO COMPETE EFFECTIVELY,
WE MUST CONTINUALLY INTRODUCE NEW PRODUCTS THAT ACHIEVE MARKET ACCEPTANCE
The emerging market for communications equipment in developing
countries is characterized by rapid technological developments, frequent new
product introductions and evolving industry and regulatory standards. Our
success will depend in large part on our ability to enhance our network access
and switching technologies and develop and introduce new products and product
enhancements that anticipate changing service provider requirements and
technological developments. We may need to make substantial capital expenditures
and incur significant research and development costs to develop and introduce
new products and enhancements. If we fail to timely develop and introduce new
products or enhancements to existing products that effectively respond to
technological change, our business, financial condition and results of
operations could be materially adversely affected.
From time to time, we or our competitors may announce new products or
product enhancements, services or technologies that have the potential to
replace or shorten the life cycles of our products and that may cause customers
to defer purchasing our existing products, resulting in inventory obsolescence.
Future technological advances in the communications industry may diminish or
inhibit market acceptance of our existing or future products or render our
products obsolete.
Even if we are able to develop and introduce new products, we cannot
assure you that they will gain market acceptance. Market
17
acceptance of our products will depend on various factors including:
- our ability to obtain necessary approvals from regulatory
organizations;
- the perceived advantages of the new products over competing products;
- our ability to attract customers who have existing relationships with
our competitors;
- product cost relative to performance; and
- the level of customer service available to support new products.
Specifically, sales of our AN-2000 system outside of China depend,
in part, on the adoption of the V5.2 standard in these markets. Additionally,
sales of our Personal Access System, or PAS, the mobile component of our
Airstar wireless system, will depend in part upon consumer acceptance of the
mobility limitations of this service. The introduction of inexpensive
wireless telephone service or other competitive services in China may have a
material adverse effect on sales of our Airstar systems in China. If our
existing or new products fail to achieve market acceptance for any reason,
our business could be seriously harmed.
OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO DELIVER QUALITY PRODUCTS ON A
TIMELY AND COST EFFECTIVE BASIS
Our operating results depend on our ability to manufacture products on
a timely and cost effective basis. In the past, we have experienced reductions
in yields as a result of various factors, including defects in component parts
and human error in assembly. If we experience a deterioration in manufacturing
performance or a delay in production of any of our products, we could experience
delays in shipments and cancellations of orders. Moreover, networking products
frequently contain undetected software or hardware defects when first introduced
or as new versions are released. In addition, our products are often embedded in
or deployed in conjunction with service providers' products which incorporate a
variety of components produced by third parties. As a result, when a problem
occurs, it may be difficult to identify the source of the problem. These
problems may cause us to incur significant warranty and repair costs, divert the
attention of our engineering personnel from our product development efforts and
cause significant customer relation problems or loss of customers, any one of
which could harm our business.
If future demand for our products requires additional manufacturing
capacity, we may invest in and build additional manufacturing facilities, most
likely in China. However, we cannot assure you that the new manufacturing
facilities will attain the same quality or level of efficiencies as our existing
facilities. Alternatively, or in addition, we may contract with third party
manufacturing facilities over which we may be unable to exercise the same degree
of quality control as we can over our own facilities. We currently have no
arrangements with any independent manufacturing facility, and we may not be able
to obtain independent manufacturing sources on commercially attractive terms if
and when needed.
WE DEPEND ON SOME SOLE SOURCE AND OTHER KEY SUPPLIERS FOR HANDSETS, COMPONENTS
AND MATERIALS USED IN OUR PRODUCTS, AND IF THESE SUPPLIERS FAIL TO PROVIDE US
WITH ADEQUATE SUPPLIES OF HIGH QUALITY PRODUCTS, OUR COMPETITIVE POSITION,
REPUTATION AND BUSINESS COULD BE HARMED
Some components and materials used in our products are purchased from a
single supplier or a limited group of suppliers. If any supplier is unwilling or
unable to provide us with high quality components and materials in the
quantities required and at the costs specified by us, we may not be able to find
alternative sources on favorable terms, in a timely manner, or at all. Our
inability to obtain or to develop alternative sources if and as required could
result in delays or reductions in manufacturing or product shipments. Moreover,
these suppliers may delay product shipments or supply us with inferior quality
products. If any of these events occur, our competitive position, reputation and
business could suffer.
OUR ABILITY TO SOURCE A SUFFICIENT QUANTITY OF HIGH QUALITY HANDSETS AND OTHER
COMPONENTS USED IN OUR PRODUCTS MAY BE LIMITED BY CHINA'S IMPORT RESTRICTIONS
AND DUTIES AS WELL AS OUR ABILITY TO OBTAIN SUFFICIENT DOMESTIC MANUFACTURING
CAPACITY
We require a significant number of imported components to manufacture
our products in China. Imported electronic components and other imported goods
used in the operation of our business are subject to a variety of permit
requirements, approval procedures and import duties. Failure to obtain necessary
permits or approvals, administrative actions by China's government to limit
imports of certain components, or non-payment of required import duties could
subject us to penalties and fines and could adversely affect our ability to
manufacture and sell our products in China. In addition, import duties increase
the cost of our products and may make them less competitive.
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In particular, an integral component of our Airstar PAS system is the
handset used by subscribers to make and receive mobile telephone calls. Our
inability to obtain a sufficient number of high quality handsets could severely
harm our business. Currently, a worldwide shortage of handsets exists. Although
we have contracted with Japanese vendors to manufacture handsets under the
UTStarcom label, we cannot assure you that they will be able to supply adequate
quantities of handsets. Moreover, we must pay an import duty on each handset
that we import into China, which may result in a competitive cost advantage for
our competitors who produce handsets in China. As a result, we are evaluating
various manufacturing alternatives within China. Currently, we are in the early
stages of negotiations with third parties to manufacture handsets for us in
China. We may be unable to enter into arrangements with third parties who are
capable of producing adequate quantities of high-quality handsets. We also
intend to develop the capacity to manufacture our own handsets. However, we may
be unsuccessful in our efforts to do so. Additionally, to comply with
manufacturing regulations in China we will need to obtain components for our
handsets from local sources. These sources may not be able to produce adequate
quantities of components that meet our quality standards.
IF WE ARE UNABLE TO EXPAND OUR DIRECT SALES OPERATION IN CHINA AND INDIRECT
DISTRIBUTION CHANNELS ELSEWHERE OR SUCCESSFULLY MANAGE OUR EXPANDED SALES
ORGANIZATION, OUR OPERATING RESULTS MAY SUFFER
Our distribution strategy focuses primarily on developing and expanding
our direct sales organization in China and our indirect distribution channels
outside of China. We may not be able to successfully expand our direct sales
organization in China and the cost of any expansion may exceed the revenue
generated from these efforts. Even if we are successful in expanding our direct
sales organization in China, we may not be able to compete successfully against
the significantly larger and better-funded sales and marketing operations of
current or potential competitors. In addition, if we fail to develop
relationships with significant international resellers or manufacturers'
representatives, or if these resellers or representatives are not successful in
their sales or marketing efforts, we may be unsuccessful in our expansion
efforts outside China.
WE EXPECT AVERAGE SELLING PRICES OF OUR PRODUCTS TO DECREASE WHICH MAY REDUCE
OUR REVENUES, AND, AS A RESULT, WE MUST INTRODUCE NEW PRODUCTS AND REDUCE OUR
COSTS IN ORDER TO MAINTAIN PROFITABILITY
The average selling prices for communications access and switching
systems and subscriber terminal products, such as handsets, in China have been
declining as a result of a number of factors, including:
- increased competition;
- aggressive price reductions by competitors;
- rapid technological change; and
- price and performance enhancements.
We have in the past experienced and expect in the future to experience
substantial period-to-period fluctuations in operating results due to declining
average selling prices. We anticipate that average selling prices of our
products will decrease in the future in response to product introductions by us
or our competitors or other factors, including price pressures from customers.
Therefore, we must continue to develop and introduce new products and
enhancements to existing products that incorporate features that can be sold at
higher average selling prices. Failure to do so could cause our revenues and
gross profit, as a percentage of net sales, to decline.
Our cost reduction efforts may not allow us to keep pace with
competitive pricing pressures or lead to improved gross profit, as a percentage
of net sales. In order to be competitive, we must continually reduce the cost of
manufacturing our products through design and engineering changes. We may not be
successful in redesigning our products or delivering our products to market in a
timely manner. We cannot assure you that any redesign will result in sufficient
cost reductions to allow us to reduce the prices of our products to remain
competitive or to improve or maintain our gross profit, as a percentage of net
sales.
SHIFTS IN OUR PRODUCT MIX MAY RESULT IN DECLINES IN GROSS MARGIN PERCENTAGE OF
NET SALES
Our gross profit margin percentage of net sales varies among our
product groups. Our gross margin percentage of net sales is generally higher on
our access network system products and our gross margin percentage of net sales
is significantly lower on our handset products. We also anticipate that the
gross margin percentage of net sales may be lower for our newly developed
products due to start-up costs and may improve as unit volumes increase and
efficiency can be realized. Our overall gross margin percentage of net sales has
fluctuated from period to period as a result of shifts in product mix, the
introduction of new products, decreases in average
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selling prices for older products and our ability to reduce product costs. As a
result of a growth in sales of handset products over the past few quarters, we
have experienced a sustained product shift toward a greater percentage of
handset products resulting in a decline in overall gross margin percentage of
net sales. In addition, we expect to introduce new products in the future
periods. As a result of these recent trends, a potential decrease in overall
gross margin percentage of net sales may be experienced over the next few
quarters.
SERVICE PROVIDERS SOMETIMES EVALUATE OUR PRODUCTS FOR LONG AND UNPREDICTABLE
PERIODS WHICH CAUSES THE TIMING OF PURCHASES AND OUR RESULTS OF OPERATIONS TO BE
UNPREDICTABLE
The period of time between our initial contact with a service provider
and the receipt of an actual purchase order may span a year or more. During this
time, service providers may subject our products to an extensive and lengthy
evaluation process before making a purchase. The length of these qualification
processes may vary substantially by product and service provider, making our
results of operations unpredictable. We may incur substantial sales and
marketing expenses and expend significant management effort during this process,
which ultimately may not result in a sale. These qualification processes often
make it difficult to obtain new customers, as service providers are reluctant to
expend the resources necessary to qualify a new supplier if they have one or
more existing qualified sources.
OUR INABILITY TO EXERCISE COMPLETE CONTROL OVER OUR SUBSIDIARIES MAY BE
DETRIMENTAL TO OUR BUSINESS
A considerable portion of our operations is and will continue to be
conducted through direct and indirect subsidiaries. For example, we own an 88%
interest in a joint venture which operates the Zhejiang manufacturing facility
and a 51% interest in a joint venture which operates the Guangdong manufacturing
facility. Even though we may own a majority interest in these joint ventures, we
do not have sole power to control all of the policies and decisions of these
jointly-owned subsidiaries.
Under the law of China governing Sino-foreign joint ventures, equity
holders exercise rights primarily through the board of directors, which
constitutes the highest authority of the joint venture. Although we own a
majority of the Guangdong joint venture, we are only entitled to appoint a
minority of the directors to the joint venture's board of directors, which
prevents us from controlling the actions of the board. Moreover, even though we
hold a majority of the board seats in the Zhejiang joint venture, China law
requires unanimous approval of the board of directors for some significant
corporate actions, including:
- amendment of the Articles of Association of the joint venture;
- liquidation or dissolution of the joint venture;
- any increase, decrease or transfer of equity interests of any
party to the joint venture; and
- a merger of the joint venture with another economic entity.
Our operating results and cash flow depend on the operating results and
cash flow of our subsidiaries and the payment of funds by those subsidiaries to
us. These subsidiaries are separate and distinct legal entities and have no
obligation, contingent or otherwise, to pay dividends or otherwise provide
financial benefits to us. Moreover, with respect to our Guangdong manufacturing
joint venture, any payment of dividends to us must be agreed to by our joint
venture partner, whose interests in receiving dividend distributions may not
coincide with ours. In addition, applicable law in some countries including
China limits the ability of a subsidiary to pay dividends for various reasons
including the absence of sufficient distributable reserves. In the event of any
insolvency, bankruptcy or similar proceedings, creditors of the subsidiaries
would generally be entitled to priority over us with respect to assets of the
affected subsidiary. In addition, because our joint venture partners in both
Zhejiang and Guangdong provinces are affiliated with the provincial Posts and
Telecommunications Administrations that operate the telecommunication networks
in these areas, if we fail to maintain these joint ventures, sales to our
customers located in these areas may decrease.
OUR MULTI-NATIONAL OPERATIONS SUBJECT US TO VARIOUS ECONOMIC, POLITICAL,
REGULATORY AND LEGAL RISKS
We market and sell our products in China and other markets. The
expansion of our existing multi-national operations and entry into additional
international markets will require significant management attention and
financial resources. Multi-national operations are subject to inherent risks,
including:
- difficulties in designing products that are compatible with
varying international communications standards;
- longer accounts receivable collection periods and greater
difficulty in accounts receivable collection;
- unexpected changes in regulatory requirements;
20
- changes to import and export regulations, including quotas,
tariffs and other trade barriers;
- delays or difficulties in obtaining export and import licenses;
- potential foreign exchange controls and repatriation controls on
foreign earnings;
- exchange rate fluctuations and currency conversion restrictions;
- the burdens of complying with a variety of foreign laws and
regulations;
- difficulties and costs of staffing and managing multi-national
operations;
- reduced protection for intellectual property rights in some
countries;
- potentially adverse tax consequences; and
- political and economic instability.
Multinational companies are required to establish intercompany pricing
for transactions between their separate legal entities operating in different
taxing jurisdictions. These intercompany transactions are subject to audit by
taxing authorities in the jurisdictions in which multinational companies
operate. An additional tax liability may be incurred if it is determined that
intercompany pricing was not done at arm's length. We believe we have adequately
estimated and recorded our liability arising from intercompany pricing, but we
cannot assure you that an additional tax liability will not result from audits
of our intercompany pricing policies.
In markets outside of China, we rely on a number of original equipment
manufacturers, or OEMs, and third-party distributors and agents to market and
sell our network access products. If these OEMs, distributors or agents fail to
provide the support and effort necessary to service developing markets
effectively, our ability to maintain or expand our operations outside of China
will be negatively impacted. We cannot assure you that we will successfully
compete in these markets, that our products will be accepted or that we will
successfully overcome the risks associated with international operations.
Our international sales are generally denominated in local currencies.
Due to the limitations on converting Renminbi, we are limited in our ability to
engage in currency hedging activities in China. Although the impact of currency
fluctuations to date has been insignificant, fluctuations in currency exchange
rates in the future may have a material adverse effect on our results of
operations. We have contracts negotiated in Japanese Yen for purchasing portions
of our inventories and supplies. We have entered into foreign currency hedging
transactions to reduce exposure to foreign exchange risks. As of June 30, 2000,
we had a forward contract to hedge Japanese Yen valued at $3.8 million.
OUR FAILURE TO MEET INTERNATIONAL AND GOVERNMENTAL PRODUCT STANDARDS COULD BE
DETRIMENTAL TO OUR BUSINESS
Many of our products are required to comply with numerous government
regulations and standards, which vary by market. As standards for products
continue to evolve, we will need to modify our products or develop and support
new versions of our products to meet emerging industry standards, comply with
government regulations and satisfy the requirements necessary to obtain
approvals. Our inability to obtain regulatory approval and meet established
standards could delay or prevent our entrance into or force our departure from
markets.
OUR RECENT GROWTH HAS STRAINED OUR RESOURCES, AND IF WE ARE UNABLE TO MANAGE AND
SUSTAIN OUR GROWTH, OUR OPERATING RESULTS WILL BE NEGATIVELY AFFECTED
We have recently experienced a period of rapid growth and anticipate
that we must continue to expand our operations to address potential market
opportunities. If we fail to implement or improve systems or controls or to
manage any future growth and expansion effectively, our business could suffer.
Our expansion has placed and will continue to place a significant
strain on our management, operational, financial and other resources. Many of
the members of our management team have limited experience in the management of
rapidly growing companies. To manage our growth effectively, we will need to
take various actions, including:
- enhancing management information systems and forecasting
procedures;
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- further developing our operating, administrative, financial and
accounting systems and controls;
- maintaining close coordination among our engineering, accounting,
finance, marketing, sales and operations organizations;
- expanding, training and managing our employee base; and
- expanding our finance, administrative and operations staff.
OUR SUCCESS IS DEPENDENT ON CONTINUING TO HIRE AND RETAIN QUALIFIED PERSONNEL,
AND IF WE ARE NOT SUCCESSFUL IN ATTRACTING AND RETAINING THESE PERSONNEL, OUR
BUSINESS WOULD BE HARMED
The success of our business depends in significant part upon the
continued contributions of key technical and senior management personnel, many
of whom would be difficult to replace. In particular, our success depends in
large part on the knowledge, expertise and services of Hong Liang Lu, our
President and Chief Executive Officer, and Ying Wu, our Executive Vice President
and Chief Executive Officer of China Operations. The loss of any key employee,
the failure of any key employee to perform satisfactorily in his or her current
position or our failure to attract and retain other key technical and senior
management employees could have a significant negative impact on our operations.
To effectively manage our recent growth as well as any future growth,
we will need to recruit, train, assimilate, motivate and retain qualified
employees. Competition for qualified employees is intense, and the process of
recruiting personnel with the combination of skills and attributes required to
execute our business strategy can be difficult, time-consuming and expensive. We
are actively searching for research and development engineers and sales and
marketing personnel, who are in short supply. Additionally, we have a need for
and have experienced difficulty in finding qualified accounting personnel
knowledgeable in U.S. and China accounting standards. If we fail to attract,
hire, assimilate or retain qualified personnel, our business would be harmed.
Competitors and others have in the past and may in the future attempt
to recruit our employees. In addition, companies in the communications industry
whose employees accept positions with competitors frequently claim that the
competitors have engaged in unfair hiring practices. We may be the subject of
these types of claims in the future as we seek to hire qualified personnel. Some
of these claims may result in material litigation and disruption to our
operations. We could incur substantial costs in defending ourselves against
these claims, regardless of their merits.
ANY ACQUISITIONS THAT WE UNDERTAKE COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR
BUSINESS, DILUTE OUR STOCKHOLDERS AND HARM OUR OPERATING RESULTS
We recently acquired Wacos, Inc., a research and development
subsidiary, through a merger. We continually evaluate additional acquisition
prospects that would complement our existing product offerings, augment our
market coverage, enhance our technological capabilities, or that may otherwise
offer growth opportunities. Acquisitions of other companies may result in
dilutive issuances of equity securities, the incurrence of debt and the
amortization of expenses related to goodwill and other intangible assets. In
addition, acquisitions involve numerous risks, including difficulties in the
assimilation of operations, technologies, products and personnel of the acquired
company, diversion of management's attention from other business concerns, risks
of entering markets in which we have no direct or limited prior experience, and
the potential loss of key employees of ours and the acquired company.
WE MAY EXPERIENCE DIFFICULTY IN IDENTIFYING, FORMING AND MAINTAINING NEW
BUSINESS VENTURES THAT ARE IMPORTANT TO THE DEVELOPMENT OF OUR BUSINESS
We have invested, and expect to continue to invest, significant capital
in new business ventures. We cannot assure you that we will be able to continue
to identify suitable parties for new ventures in the future. The failure to form
or maintain new ventures could significantly limit our ability to expand our
operations. Moreover, these new ventures or investments require significant
management time, involve a high degree of risk and will present significant
challenges. We cannot assure you that these activities will be successful or
that we will realize appropriate returns on these activities. Additionally, if
any venture or investment fails, our business could be negatively impacted.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY AND MAY BE
SUBJECT TO CLAIMS THAT WE INFRINGE THE INTELLECTUAL PROPERTY OF OTHERS, EITHER
OF WHICH COULD SUBSTANTIALLY HARM OUR BUSINESS
We rely on a combination of patents, copyrights, trade secret laws
and contractual obligations to protect our technology. Although we have
applied for several patents in the United States, one of which has been
issued, as well as in other countries, we cannot assure you that any
additional patents will be issued as a result of pending patent applications
or that our issued patents will be upheld. Moreover, we
22
have not yet obtained patents in China. We can give no assurance that we will be
able to obtain patents in China on our products or the technology that we use to
manufacture our products. Our subsidiaries and joint ventures in China rely upon
our trademarks, technology and know-how to manufacture and sell our products. We
cannot guarantee that these and other intellectual property protection measures
will be sufficient to prevent misappropriation of our technology or that our
competitors will not independently develop technologies that are substantially
equivalent or superior to ours. In addition, the legal systems of many foreign
countries, including China, do not protect intellectual property rights to the
same extent as the legal system of the United States. If we are unable to
adequately protect our proprietary information, our business, financial
condition and results of operations could be materially adversely affected.
The increasing dependence of the communications industry on proprietary
technology has resulted in frequent litigation based on allegations of the
infringement of patents and other intellectual property. In the future we may be
subject to litigation to defend against claimed infringements of the rights of
others or to determine the scope and validity of the proprietary rights of
others. Future litigation also may be necessary to enforce and protect our trade
secrets and other intellectual property rights. Any intellectual property
litigation could be costly and could cause diversion of management's attention
from the operation of our business. Adverse determinations in any litigation
could result in the loss of our proprietary rights, subject us to significant
liabilities or require us to seek licenses from third parties which may not be
available on commercially reasonable terms, if at all. We could also be subject
to court orders preventing us from manufacturing or selling our products.
RISKS RELATING TO CHINA
Sales in China account for substantially all of our sales.
Approximately $102.9 million, or 97.9%, of our sales in 1998, $186.1 million, or
99.3% of our sales in 1999, and $79.1 million, or 98.8% of our sales in the
second quarter of 2000 occurred in China. Additionally, a substantial portion of
our fixed assets are located in China. Of our total fixed assets, approximately
46.4% as of December 31, 1998, 53.7% as of December 31, 1999 and 48.0% as of
June 30, 2000 were in China. We expect to make further investments in China in
the future. Therefore, our business, financial condition and results of
operations are to a significant degree subject to economic, political and social
events in China.
DEVALUATION IN THE VALUE OF THE RENMINBI AND FLUCTUATIONS IN EXCHANGE RATES
COULD ADVERSELY AFFECT OUR FINANCIAL RESULTS
Exchange rate fluctuations could have a substantial negative impact on
our financial condition and results of operations. We purchase substantially all
of our materials in the United States and Japan and a significant portion of our
cost of goods sold is incurred in U.S. dollars and Japanese yen. A significant
portion of our operating expenses are incurred in U.S. dollars. At the same
time, most of our sales are denominated in Renminbi. The value of the Renminbi
is subject to changes in China's governmental policies and to international
economic and political developments. Although the official exchange rate for the
conversion of Renminbi to U.S. dollars has remained stable, with the Renminbi
appreciating slightly against the U.S. dollar since 1994, the exchange rate
experienced significant volatility prior to 1994 including periods of sharp
devaluation. There can be no assurance that exchange rates will not become
volatile or that the Renminbi will not devalue again against the U.S. dollar.
In the past, financial markets in many Asian countries have experienced
severe volatility and, as a result, some Asian currencies have experienced
significant devaluation from time to time. The devaluation of some Asian
currencies may have the effect of rendering exports from China more expensive
and less competitive and therefore place pressure on China's government to
devalue the Renminbi. Any devaluation of the Renminbi could result in an
increase in volatility of Asian currency and capital markets. Future volatility
of Asian financial markets could have an adverse impact on our ability to expand
our product sales into Asian markets outside of China. Moreover, due to the
limitations on the convertibility of Renminbi, we are limited in our ability to
engage in currency hedging activities in China and do not currently engage in
currency hedging activities with respect to international sales outside of
China.
CURRENCY RESTRICTIONS IN CHINA MAY LIMIT THE ABILITY OF OUR SUBSIDIARIES AND
JOINT VENTURES IN CHINA TO OBTAIN AND REMIT FOREIGN CURRENCY NECESSARY FOR THE
PURCHASE OF IMPORTED COMPONENTS AND MAY LIMIT OUR ABILITY TO OBTAIN AND REMIT
FOREIGN CURRENCY IN EXCHANGE FOR RENMINBI EARNINGS
China's government imposes controls on the convertibility of Renminbi
into foreign currencies and, in certain cases, the remittance of currency out of
China. Under the current foreign exchange control system, sufficient foreign
currency may not be available to satisfy our currency needs. Shortages in the
availability of foreign currency may restrict the ability of our Chinese
subsidiaries to obtain and remit sufficient foreign currency to pay dividends to
us, or otherwise satisfy their foreign currency denominated obligations such as
payments to us for components which we export to them and for technology
licensing fees. We may also experience difficulties in completing the
administrative procedures necessary to obtain and remit needed foreign currency.
Moreover, we cannot assure you that China's government will continue the policy
of making the Renminbi convertible under current accounts. Our inability to
convert and remit our sales received in Renminbi into U.S. dollars and make
necessary remittances could have a material adverse effect on our
23
business, financial condition and results of operations.
Our business could be substantially harmed if we are unable to convert
our sales received in Renminbi into U.S. dollars. Under existing foreign
exchange laws, Renminbi held by our China subsidiaries can be converted into
foreign currencies and remitted out of China to pay current account items such
as payments to suppliers for imports, labor services, payment of interest on
foreign exchange loans and distributions of dividends so long as the
subsidiaries have adequate amounts of Renminbi to purchase the foreign currency.
Expenses of a capital nature such as the repayment of bank loans denominated in
foreign currencies, however, require approval from appropriate governmental
authorities before Renminbi can be used to purchase foreign currency and then
remitted out of China. This system could be changed at any time by executive
decision of the State Council to impose limits on current account convertibility
of the Renminbi or other similar restrictions. Moreover, even though the
Renminbi is intended to be freely convertible under the current account, the
State Administration of Foreign Exchange, which is responsible for administering
China's foreign currency market, has a significant degree of administrative
discretion in implementing the laws. From time to time, the State Administration
of Foreign Exchange has used this discretion in ways which effectively limit the
convertibility of current account payments and restrict remittances out of
China. Furthermore, in many circumstances the State Administration of Foreign
Exchange must approve foreign currency conversions and remittances. Under the
current foreign exchange control system, sufficient foreign currency may not be
available at a given exchange rate to satisfy our currency demands.
CHANGES WITHIN CHINA'S COMMUNICATIONS MARKET COULD HARM OUR BUSINESS
We derive substantially all of our sales from local telecommunications
service providers in China which utilize network access equipment in the
continued expansion and upgrading of China's communications infrastructure. The
continued development of the communications infrastructure in China
correspondingly depends, in part, on the demand for voice and data services in
China and China's governmental policy. Although this industry has grown rapidly
in the past, we cannot assure you that it will continue to grow in the future.
Any reduced demand for voice and data services, any other downturn or
other adverse changes in the China communications industry or the adoption or
enforcement of government policies that limit or prohibit our ability to
manufacture, market or sell our products could severely harm our business.
CHINA'S TELECOMMUNICATIONS INDUSTRY IS SUBJECT TO EXTENSIVE GOVERNMENT
REGULATION AND HAS RECENTLY BEEN RESTRUCTURED, WHICH HAS LED TO UNCERTAINTY
China's telecommunications industry is heavily regulated by the
Ministry of Information Industry. The Ministry of Information Industry controls
the 33 provincial Posts and Telecommunications Administrations that exercise
regulatory responsibility over the telecommunications industries in their
respective provinces. The Ministry of Information Industry has broad discretion
and authority to regulate all aspects of the telecommunications and information
technology industry in China including managing spectrum bandwidths, setting
network equipment specifications and standards and drafting laws and regulations
related to the electronics and telecommunications industries.
As part of the Chinese government's industry restructuring initiatives,
the regulatory functions of the Ministry of Information Industry and the Posts
and Telecommunications Administrations will be separated from the operational
functions of the state-owned companies under their control. Following this
separation, it is expected that the Ministry of Information Industry will act
exclusively as the industry regulator and will no longer manage the day-to-day
operations of telecommunications service providers in China. The separation of
the regulatory and operational functions of the Ministry of Information Industry
and the Posts and Telecommunications Administrations has not been completed. As
a result, the Ministry of Information Industry continues to exercise
administrative control over the operational goals and policies of
telecommunications service providers formerly under the control of the China
Telecom system. In addition, the provincial Posts and Telecommunications
Administrations continue to operate the fixed line telephone systems in their
respective provinces. We cannot predict when complete separation of the
regulatory and operational functions of the Ministry of Information Industry and
the provincial Posts and Telecommunications Administrations will be achieved.
China does not yet have a national telecommunications law. The Ministry
of Information Industry, under the direction of the State Council, is currently
preparing a draft of the Telecommunications Law of the People's Republic of
China for ultimate submission to the National People's Congress for review and
adoption. It is unclear if and when the Telecommunications Law will be adopted.
If the Telecommunications Law is adopted, we expect it to become the basic
telecommunications statute and the source of telecommunications regulations in
China. Although we expect that a Telecommunications Law would have a positive
effect on the overall development of the telecommunications industry in China,
we do not know the nature and scope of regulation that it would create.
Accordingly, we cannot predict whether it will have a positive or negative
effect on us or on some or all aspects of our business.
The Ministry of Information Industry has broad discretion to apply
standards in deciding what types of equipment may be connected to the national
telecommunications networks, the forms and types of services that may be offered
to the public and the content of material available in China over the Internet.
If the Ministry of Information Industry sets standards with which we are unable
to
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comply, our ability to sell product in China may be limited, resulting in
substantial harm to our operations. For example, at the end of May 2000, we
became aware of an internal notice, circulated within the Ministry of
Information Industry, announcing a review of PHS-based telecommunications
equipment for future installation into China's telecommunications
infrastructure in which the Ministry of Information Industry requested
service providers to temporarily halt new deployments of PHS-based
telecommunications equipment, including our Airstar system, pending
conclusion of the Ministry of Information Industry review. Subsequently, at
the end of June 2000, we learned that the Ministry of Information Industry had
issued an internal notice concluding its review of PHS-based equipment and
allowing the continued deployment of our Airstar system in China's
county-level cities and counties, the primary markets for our Airstar system.
In addition, deployments in large and medium-sized cities will be allowed on
a limited basis where there is a high concentration of population, such as
campuses, commercial buildings and special development zones, however, new
city-wide deployments of our Airstar system will not be allowed in such large
and medium-sized cities. Failure of the Ministry of Information Industry to
allow the deployment of our Airstar system in the future could have a
material adverse effect on our business and financial condition.
CHINA CLOSELY RESTRICTS ACTIVITIES OF FOREIGN INVESTORS IN THE
TELECOMMUNICATIONS INDUSTRY
China's government and its agencies, including the Ministry of
Information Industry and the State Council, regulate foreign investment in the
telecommunications industry through the promulgation of various laws and
regulations and the issuance of various administrative orders and decisions.
Foreign investment enterprises, companies and individuals are prohibited from
investing and participating in the operation and management of
telecommunications networks without special approval by the State Council. In
addition, they are restricted from manufacturing analog mobile communications
systems, including wireless telephones. We cannot assure you that China will not
promulgate new laws or regulations, or issue administrative or judicial
decisions or interpretations, which would further restrict or bar foreigners
from engaging in telecommunications-related activities. The promulgation of laws
or regulations or the issuance of administrative orders or judicial decisions or
interpretations restricting or prohibiting telecommunications activities by
foreigners could have a substantial impact on our ongoing operations.
OUR CUSTOMERS IN CHINA ARE PART OF THE CHINA TELECOM SYSTEM AND ARE SUBJECT TO
ITS ULTIMATE CONTROL. WE UNDERSTAND THAT CHINA TELECOM RECENTLY PROHIBITED ALL
POSTS AND TELECOMMUNICATIONS BUREAUS IN CHINA FROM PURCHASING LOW-MOBILITY
WIRELESS ACCESS SYSTEMS, SUCH AS OUR PAS SYSTEM, FOR IMPLEMENTATION IN LARGE
CITIES
Each of the local Posts and Telecommunications Bureaus in China which
comprise our existing or potential customers is part of the China Telecom system
and subject to its ultimate control. Accordingly, China Telecom may issue policy
statements or make other decisions which govern the equipment purchasing
decisions of all of our customers in China. For example, we understand that
China Telecom recently prohibited all Posts and Telecommunications Bureaus from
purchasing PHS systems, such as our PAS systems, which are classified as
low-mobility wireless access systems for implementation in large cities. While
to date we have not marketed or sold our PAS systems in large cities, we may
wish to do so in the future. As the majority of our sales are generated from our
operations in China, this decision of China Telecom or other decisions by China
Telecom could cause substantial harm to our business.
CHINA'S GOVERNMENT POLICIES COULD IMPACT OUR BUSINESS
Since 1978, China's government has been and is expected to continue
reforming its economic and political systems. These reforms have resulted in and
are expected to continue to result in significant economic and social
development in China. Many of the reforms are unprecedented or experimental and
may be subject to change or readjustment due to a number of political, economic
and social factors. We believe that the basic principles underlying the
political and economic reforms will continue to be implemented and provide the
framework for China's political and economic system. New reforms or the
readjustment of previously implemented reforms could have a significant negative
effect on our operations. Changes in China's political, economic and social
conditions and governmental policies which could have a substantial impact on
our business include:
- new laws and regulations or the interpretation of those laws and
regulations;
- the introduction of measures to control inflation or stimulate
growth;
- changes in the rate or method of taxation;
- the imposition of additional restrictions on currency conversion
and remittances abroad; and
- any actions which limit our ability to develop, manufacture,
import or sell our products in China, or to finance and operate
our business in China.
CHINA'S ECONOMIC POLICIES COULD IMPACT OUR BUSINESS
The economy of China differs from the economies of most countries
belonging to the Organization for Economic Cooperation and Development in
various respects such as structure, government involvement, level of
development, growth rate, capital reinvestment, allocation of resources,
self-sufficiency, rate of inflation and balance of payments position. In the
past, the economy of China has been primarily a planned economy subject to
one-and five-year state plans adopted by central government authorities and
largely implemented by provincial and local authorities which set production and
development targets.
Since 1978, increasing emphasis had been placed on decentralization and
the utilization of market forces in the development of China's economy. Economic
reform measures adopted by China's government may be inconsistent or
ineffectual, and we may not in all cases be able to capitalize on any reforms.
Further, these measures may be adjusted or modified in ways which could result
in economic liberalization measures that are inconsistent from time to time or
from industry to industry or across different regions of the country.
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China's economy has experienced significant growth in the past decade. This
growth, however, has been accompanied by imbalances in China's economy and has
resulted in significant fluctuations in general price levels, including periods
of inflation. China's government has implemented policies from time to time to
increase or restrain the rate of economic growth, control periods of inflation
or otherwise regulate economic expansion. While we may be able to benefit from
the effects of some of these policies, these policies and other measures taken
by China's government to regulate the economy could also have a significant
overall impact on economic conditions in China with a resulting negative impact
on our business.
CHINA'S EXPECTED ENTRY INTO THE WTO CREATES UNCERTAINTY AS TO THE FUTURE
ECONOMIC AND BUSINESS ENVIRONMENTS IN CHINA
China has been attempting to join the World Trade Organization and
recently signed bilateral trade agreements with the United States and European
Union which have enabled China to gain the support of the United States and
European Union in China's attempt to enter the WTO. With these agreements
concluded, China is expected to enter into the WTO as early as some time in
2000. Although China has been reducing tariff levels over the past several
years, entry into the WTO will require China to further reduce tariffs and
eliminate other trade restrictions. While China's entry into the WTO and related
relaxation of trade restrictions may lead to increased foreign investment, it
may also lead to increased competition in China's markets from international
companies. Whether or not China is accepted into the WTO, the impact on China's
economy and our business is uncertain.
IF TAX BENEFITS AVAILABLE TO OUR SUBSIDIARIES LOCATED IN CHINA ARE REDUCED OR
REPEALED, OUR BUSINESS COULD SUFFER
Our subsidiaries and joint ventures located in China enjoy tax benefits
in China which are generally available to foreign investment enterprises,
including full exemption from national enterprise income tax for two years
starting from the first profit-making year and/or a 50% reduction in national
income tax rate for the following three years. In addition, local enterprise
income tax is often waived or reduced during this tax holiday/incentive period.
Under current regulations in China, foreign investment enterprises that have
been accredited as technologically advanced enterprises are entitled to
additional tax incentives. These tax incentives vary in different locales and
could include preferential national enterprise income tax treatment at 50% of
the usual rates for different periods of time. All of our active subsidiaries in
China were accredited as technologically advanced enterprises. These tax
incentives may be repealed or reduced in the future. If these tax incentives are
abolished before our subsidiaries in China can take full advantage of them, the
tax liability of these subsidiaries will increase, which will negatively impact
our financial condition and results of operations.
CHINA'S LEGAL SYSTEM EMBODIES UNCERTAINTIES THAT COULD NEGATIVELY IMPACT OUR
BUSINESS
China has a civil law legal system. Although often used by judges for
guidance, decided court cases do not have binding legal effect on future
decisions. Since 1979, many new laws and regulations covering general economic
matters have been promulgated in China. Despite this activity to develop the
legal system, China's system of laws is not yet complete. Even where adequate
law exists in China, enforcement of existing laws or contracts based on existing
law may be uncertain and sporadic and it may be difficult to obtain swift and
equitable enforcement, or to obtain enforcement of a judgment by a court of
another jurisdiction. The relative inexperience of China's judiciary in many
cases creates additional uncertainty as to the outcome of any litigation.
Further, interpretation of statutes and regulations may be subject to government
policies reflecting domestic political changes.
China has adopted a broad range of related laws, administrative rules
and regulations that govern the conduct and operations of foreign investment
enterprises and restrict the ability of foreign companies to conduct business in
China. These laws, rules and regulations provide some incentives to encourage
the flow of investment into China, but also subject foreign companies, and
foreign investment enterprises including our subsidiaries in China, to a set of
restrictions which may not always apply to domestic companies in China. Although
China is increasingly according foreign companies and foreign investment
enterprises established in China the same rights and privileges as Chinese
domestic companies in anticipation of China's entry into the WTO, these special
laws, administrative rules and regulations governing foreign companies and
foreign investment enterprises may still place us and our subsidiaries at a
disadvantage in relation to Chinese domestic companies and may adversely affect
our competitive position. Moreover, as China's legal system develops, the
promulgation of new laws, changes to existing laws and the pre-emption of local
regulations by national laws may adversely affect foreign investors and
companies.
Many of our activities and products in China are subject to
administrative review and approval by various national and local agencies of
China's government. Because of the changes occurring in China's legal and
regulatory structure, there can be no assurance that we will be able to secure
the requisite governmental approval for our activities and products. Failure to
obtain the requisite government approval for any of our activities or products
could substantially harm our business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
UTStarcom is exposed to the impact of interest rate changes and changes
in foreign currency exchange rates.
26
Interest Rate Risk. Our exposure to market risk for changes in interest
rates relates primarily to our investment portfolio. The fair value of our
investment portfolio or related income would not be significantly affected by
either a 10% increase or decrease in interest rates due mainly to the short term
nature of our investment portfolio. Our interest income is sensitive to changes
in the general level of U.S. interest rates, particularly since the majority of
our funds are invested instruments with maturities less than one year.
UTStarcom's policy is to limit the risk of principal loss and ensure the safety
of invested funds by limiting market risk. Funds in excess of current operating
requirements are invested in government sponsored entities notes, commercial
paper, floating rate corporate bonds and fixed income corporate bonds.
The table below represents carrying amounts and related
weighted-average interest rates of maturity of UTStarcom's investment portfolio
at June 30, 2000:
2000
(In thousands, except interest rates)
Cash and cash equivalents 201,663
Average interest rate 5.4%
Short-term investments 45,390
Average interest rate 6.7%
Total investment securities 247,053
Average interest rate 5.6%
Foreign Exchange Rate Risk. We are exposed to foreign exchange rate
risk because our sales to China are denominated in Renminbi and portions of our
accounts payable are denominated in Japanese Yen. Due to the limitations on
converting Renminbi, we are limited in our ability to engage in currency hedging
activities in China. Although the impact of currency fluctuations of Renminbi to
date has been insignificant, fluctuations in currency exchange rates in the
future may have a material adverse effect on our results of operations. We have
contracts negotiated in Japanese Yen for purchasing portions of our inventories
and supplies. We have entered into foreign currency hedging transactions to
reduce exposure to foreign exchange risks. As of June 30, 2000, we had a forward
contract to hedge Japanese Yen valued at $3.8 million. The contract was entered
into on February 22, 2000.
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PART II - OTHER INFORMATION
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company commenced its initial public offering ("IPO") on March 3,
2000 pursuant to a Registration Statement on Form S-1 (File No. 333-93069). In
the IPO, the Company sold an aggregate of 11,500,000 shares of common stock
(including an over-allotment option of 1,500,000 shares) at $18.00 per share,
after which the IPO terminated.
The managing underwriters of the offering were Merrill Lynch & Co.,
Banc of America Securities LLC, U.S. Bancorp Piper Jaffray, Merrill Lynch Japan
Inc., and E-TRADE Securities Co., Ltd. The sale of the shares of common stock
generated aggregate gross proceeds of approximately $207.0 million for the
Company. The aggregate net proceeds were approximately $189.4 million, after
deducting underwriting discounts and commissions of approximately $14.5 million
and expenses of the offering of approximately $3.1million. None of such amounts
were direct or indirect payments to directors or officers of the Company or
their associates, to persons owning 10 percent or more of any class of equity
securities of the Company or to affiliates of the Company.
As of the effective date of the offering, all of the convertible
preferred stock outstanding was converted into 70,377,322 shares of common
stock. The net proceeds are expected to be used for general corporate purposes,
including working capital and capital expenditures. The amounts actually
expended for such purposes may vary significantly and will depend on a number of
factors, including the Company's future revenues and cash generated by
operations and the other factors described under "Factors Affecting Future
Operating Results". Accordingly, the Company retains broad discretion in the
allocation of the net proceeds of the offering. A portion of the net proceeds
may also be used to acquire or invest in complementary businesses, technologies
or product offerings. As of June 30, 2000, the Company has not used any of the
net proceeds and the entire amounts of net proceeds remains in our cash and cash
equivalents and short-term investments accounts. In addition, at June 30, 2000,
there are no material agreements or commitments with respect to any acquisition
or investment activities.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
NUMBER EXHIBIT DESCRIPTION
------ -------------------
10.1(1) Joint Venture Agreement between SOFTBANK Corporation and
UTStarcom, Inc., dated May 29, 2000.
10.2(2) Land Use Right Assignment Agreement between the Administration
Committee of Hangzhou Hi-Tech Industry Development Zone of
Zhejiang Province of the People's Republic of China and
UTStarcom, Inc., dated May 18, 2000.
10.3(3) Supply Agreement between Matsushita Electric Industrial Co.,
Ltd., Matsushita Communications Industrial Co., Ltd., and
UTStarcom, Inc., dated April 1, 2000.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the quarter.
- -----------------------
1 Certain information in this Exhibit has been omitted and filed
separately with the Commission. Confidential treatment has been requested with
respect to the omitted portions.
2 See Footnote 1.
3 See Footnote 1.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 14, 2000
UTSTARCOM, INC.
(Registrant)
BY
/s/ Hong Liang Lu
--------------------------------
Hong Liang Lu
President, Chief Executive Officer
and Director
/s/ Michael J. Sophie
--------------------------------
Michael J. Sophie
Vice President of Finance, Chief
Financial Officer
and Assistant Secretary
29